Money and Banking Notes

barter

literally, trading one good or service for another, without using money

Double coincidence of wants

a situation in which two people each want some good or service that the other person can provide

functions of money

• Medium of exchange

• Store of value even with inflation

• Unit of account

medium of exchange

money acts as an intermediary between the buyer and the seller; money must be widely accepted as a method of payment in the markets for goods, labor, and financial capital

unit of account

acts as a common denominator, simplifies thinking about tradeoffs

Commodity money

an item that is used as money, but which also has value from its use as something other than money (example: gold, silver, cocoa beans)

Commodity‐backed currencies

dollar bills or other currencies with value backed up by gold or another commodity

fiat money

has no intrinsic value, but is declared by a government to be the legal tender of a country

liquidity

the ability or ease with which assets can be converted into cash

M1 money supply

includes money that is very liquid (cash, checkable (demand) deposits, traveler’s checks)

M2 money supply

less liquid; includes everything in M1 PLUS savings deposits, money market funds, and certificates of deposit

debit card

an instruction to the user’s bank to transfer money directly and immediately from your bank account to the seller (similar to a check)

credit card

a short term loan from the credit card company to you (not considered money)

The role of banks

• payment system

• lower transaction costs

• financial intermediary

• depository institutions

payment system

helps an economy exchange goods and services for money or other financial assets

transaction costs

costs associated with finding a lender or a borrower and act as financial intermediaries – bringing savers and borrowers together

financial intermediary

an institution that operates between a saver who deposits money in a bank and a borrower who receives a loan from that bank

depository institutions

they accept money deposits and then use them to make loans

balance sheet

an accounting tool that lists assets and liabilities

asset

something of value that is owned and can be used to produce something (example: cash you own that can be used to pay your tuition, a home)

liability

a debt or something you owe (example: mortgage)

net worth

the asset value minus how much is owed (the liability)

How Banks Go Bankrupt

• Unexpected number of loan defaults

• Asset‐liability time mismatch

Asset‐liability time mismatch

a bank’s liabilities can be withdrawn in the short term while its assets are repaid in the long term; disconnect with interest rates

how to combat these risks

• Diversify its loans

• Sell some loans on the secondary loan market

• Hold a greater share of assets in the form of government bonds or reserves

diversify loans

lending to a variety of customers

how banks make money

• The banking system can literally create money through the process of making loans

• If all banks loan out their excess reserves, the money supply will expand.

• The money multiplier tells us by how many times a loan will be “multiplied” as it is spent in the economy and then re‐deposited in other banks

• The money multiplier

• The money multiplier is dependent on people re‐depositing money; if they store the cash outside of banks, instead, the money cannot be re‐circulated

money multiplier

tells us by how many times a loan will be “multiplied” as it is spent in the economy and then re‐deposited in other banks

C

What is one major downside of a barter system?
A. It encourages saving
B. It increases efficiency
C. It requires a double coincidence of wants
D. It simplifies future contracts

D

Which of the following is NOT one of the three main functions of money?
A. Unit of account
B. Medium of exchange
C. Store of value
D. Tool of investment

C

What type of money has no intrinsic value but is declared legal tender by a government?
A. Commodity money
B. Gold-backed money
C. Fiat money
D. Cryptocurrency

C

What does the M1 money supply include?
A. Savings accounts, CDs, and government bonds
B. Only currency in circulation
C. Traveler’s checks, cash, and checkable deposits
D. Stocks and corporate bonds

B

Which component is not included in M2 but is included in M1?
A. Money market funds
B. Traveler’s checks
C. Time deposits
D. Savings deposits

C

What role do banks play in the payment system?
A. They act only as lenders
B. They print money for the economy
C. They facilitate exchanges by lowering transaction costs
D. They create laws regulating currency

C

In a bank’s balance sheet, loans and reserves are considered:
A. Liabilities
B. Net worth
C. Assets
D. Expenses

C

What is the money multiplier dependent on?
A. The unemployment rate
B. The amount people keep in wallets
C. Reserve requirements and redepositing behavior
D. Government bonds

B

What does it mean if a bank has negative net worth?
A. It’s operating with too many reserves
B. Its liabilities exceed its assets
C. It’s maximizing profit
D. It has more loans than deposits

C

Why are credit cards not considered money?
A. They have too much interest
B. They are just a method of payment
C. They are loans, not actual currency
D. They are not widely accepted